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PB > SEC Filings for PB > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for PROSPERITY BANCSHARES INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for PROSPERITY BANCSHARES INC


9-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Special Cautionary Notice Regarding Forward-Looking Statements

Statements and financial discussion and analysis contained in this quarterly report on Form 10-Q that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on assumptions and involve a number of risks and uncertainties, many of which are beyond the Company's control. Many possible events or factors could affect the future financial results and performance of the Company and could cause such results or performance to differ materially from those expressed in the forward-looking statements. These possible events or factors include, without limitation:

• changes in the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations resulting in, among other things, a deterioration in credit quality or reduced demand for credit, including the result and effect on the Company's loan portfolio and allowance for credit losses;

• changes in interest rates and market prices, which could reduce the Company's net interest margins, asset valuations and expense expectations;

• changes in the levels of loan prepayments and the resulting effects on the value of the Company's loan portfolio;

• changes in local economic and business conditions which adversely affect the Company's customers and their ability to transact profitable business with the company, including the ability of the Company's borrowers to repay their loans according to their terms or a change in the value of the related collateral;

• increased competition for deposits and loans adversely affecting rates and terms;

• the timing, impact and other uncertainties of any future acquisitions, including the Company's ability to identify suitable future acquisition candidates, the success or failure in the integration of their operations, and the ability to enter new markets successfully and capitalize on growth opportunities;

• the possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on the results of operations;

• increased credit risk in the Company's assets and increased operating risk caused by a material change in commercial, consumer and/or real estate loans as a percentage of the total loan portfolio;

• the concentration of the Company's loan portfolio in loans collateralized by real estate;

• the failure of assumptions underlying the establishment of and provisions made to the allowance for credit losses;

• changes in the availability of funds resulting in increased costs or reduced liquidity;

• a deterioration or downgrade in the credit quality and credit agency ratings of the securities in the Company's securities portfolio;

• increased asset levels and changes in the composition of assets and the resulting impact on the Company's capital levels and regulatory capital ratios;

• the Company's ability to acquire, operate and maintain cost effective and efficient systems without incurring unexpectedly difficult or expensive but necessary technological changes;

• the loss of senior management or operating personnel and the potential inability to hire qualified personnel at reasonable compensation levels;

• government intervention in the U.S. financial system;

• changes in statutes and government regulations or their interpretations applicable to financial holding companies and the Company's present and future banking and other subsidiaries, including changes in tax requirements and tax rates;

• increases in FDIC deposit insurance assessments;

• acts of terrorism, an outbreak of hostilities or other international or domestic calamities, weather or other acts of God and other matters beyond the Company's control; and

• other risks and uncertainties listed from time to time in the Company's reports and documents filed with the Securities and Exchange Commission.

A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen these assumptions or bases in good faith and that they are reasonable. However, the Company cautions you that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. The Company undertakes no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise.


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Management's Discussion and Analysis of Financial Condition and Results of Operations analyzes the major elements of the Company's interim consolidated financial statements and accompanying notes. This section should be read in conjunction with the Company's interim consolidated financial statements and accompanying notes included elsewhere in this report and with the consolidated financial statements and accompanying notes and other detailed information appearing in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

OVERVIEW

The Company, a Texas corporation, was formed in 1983 as a vehicle to acquire the former Allied First Bank in Edna, Texas which was chartered in 1949 as The First National Bank of Edna. The Company is a registered financial holding company that derives substantially all of its revenues and income from the operation of its bank subsidiary, Prosperity Bankฎ ("Prosperity Bankฎ" or the "Bank"). The Bank provides a wide array of financial products and services to small and medium-sized businesses and consumers. As of September 30, 2012, the Bank operated two hundred thirteen (213) full-service banking locations; with ten
(10) in the Bryan/College Station area, thirty-four (34) in the Central Texas area, thirty-five (35) in the Dallas/Fort Worth area, twenty-one (21) in East Texas, fifty-nine (59) in the Houston area, twenty (20) in the South Texas area including Corpus Christi and Victoria, and thirty-four (34) in the West Texas area. The Company's headquarters are located at Prosperity Bank Plaza, 4295 San Felipe in Houston, Texas and its telephone number is (281) 269-7199. The Company's website address is www.prosperitybanktx.com. Information contained on the Company's website is not incorporated by reference into this quarterly report on Form 10-Q and is not part of this or any other report.

The Company generates the majority of its revenues from interest income on loans, service charges on customer accounts and income from investment in securities. The revenues are partially offset by interest expense paid on deposits and other borrowings and non-interest expenses such as administrative and occupancy expenses. Net interest income is the difference between interest income on earning assets such as loans and securities and interest expense on liabilities such as deposits and borrowings which are used to fund those assets. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and margin.

Three principal components of the Company's growth strategy are internal growth, stringent cost control practices and strategic merger transactions. The Company focuses on continual internal growth. Each banking center is operated as a separate profit center, maintaining separate data with respect to its net interest income, efficiency ratio, deposit growth, loan growth and overall profitability. Banking center presidents and managers are accountable for performance in these areas and compensated accordingly. The Company also focuses on maintaining stringent cost control practices and policies. The Company has invested significantly in the infrastructure required to centralize many of its critical operations, such as data processing and loan application processing. Management believes that this centralized infrastructure can accommodate substantial additional growth while enabling the Company to minimize operational costs through certain economies of scale. The Company also intends to continue to seek expansion opportunities. On January 1, 2012, the Company completed the acquisition of Texas Bankers, Inc. which added three banking centers, of which two were consolidated with nearby existing banking centers. On April 1, 2012, the Company completed the acquisition of The Bank Arlington which added one banking center. On July 1, 2012, the Company completed the acquisition of American State Financial Corporation ("ASB"), which added 37 banking centers. On October 1, 2012, the Company completed the acquisition of Community National Bank which added one banking center. In addition, the Company has previously announced the pending acquisition of East Texas Financial Services, Inc.

Total assets were $13.71 billion at September 30, 2012 compared with $9.82 billion at December 31, 2011, an increase of $3.89 billion or 39.6%. Total loans were $5.08 billion at September 30, 2012 compared with $3.77 billion at December 31, 2011, an increase of $1.31 billion or 34.9%. Total deposits were $10.95 billion at September 30, 2012 compared with $8.06 billion December 31, 2011, an increase of $2.89 billion or 35.9%. Total shareholders' equity was $2.04 billion at September 30, 2012 compared with $1.57 billion at December 31, 2011, an increase of $470.9 million or 30.0%. The increases were primarily due to the acquisition of ASB on July 1, 2012.

RECENT AND PENDING ACQUISTIONS

Acquisition of American State Financial Corporation-On July 1, 2012, the Company completed the previously announced acquisition of American State Financial Corporation and its wholly owned subsidiary American State Bank (collectively referred to as "ASB"). ASB operated thirty-seven (37) full service banking offices in eighteen (18) counties across West Texas.

As of June 30, 2012, ASB, on a consolidated basis, reported total assets of $3.16 billion, total loans of $1.24 billion and total deposits of $2.51 billion. Under the terms of the merger agreement, the Company issued 8,524,835 shares of Company common stock plus $178.5 million in cash for all outstanding shares of American State Financial Corporation capital stock, for total merger consideration of $536.8 million and an initial premium of $240.4 million.


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Acquisition of Community National Bank-On October 1, 2012, the Company completed the previously announced acquisition of Community National Bank, Bellaire, Texas. Community National Bank operated one (1) banking office in Bellaire, Texas, in the Houston Metropolitan Area. The acquisition is not considered significant to the Company's financial statements and therefore pro forma financial data is not included. The Company incurred approximately $326,000 in expense related to this acquisition which is primarily recorded in legal and professional fees and data processing.

As of September 30, 2012, Community National Bank reported total assets of $183.0 million, total loans of $68.0 million and total deposits of $164.6 million. Under the terms of the acquisition agreement, the Company issued 372,282 shares of Company common stock plus $11.4 million in cash for all outstanding shares of Community National Bank capital stock which resulted in a premium of $10.6 million.

Pending Acquisition of East Texas Financial Services, Inc.-On December 9, 2011, the Company entered into a definitive agreement to acquire East Texas Financial Services, Inc. (OTC BB: FFBT) and its wholly-owned subsidiary, First Federal Bank Texas ("Firstbank"). Firstbank operates four banking offices in the Tyler MSA, including three locations in Tyler, Texas and one location in Gilmer, Texas.

As of September 30, 2012, Firstbank reported total assets of $191.1 million, total loans of $139.2 million and total deposits of $116.0 million. Under the terms of the definitive agreement, the Company will issue up to 531,000 shares of Company common stock for all outstanding shares of East Texas Financial Services capital stock, subject to certain conditions and potential adjustments. Pending the satisfaction of closing conditions, the closing is expected to occur in early 2013.

CRITICAL ACCOUNTING POLICIES

The Company's accounting policies are integral to understanding the financial results reported. Accounting policies are described in detail in Note 1 to the consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2011. The Company believes that of its significant accounting policies, the following may involve a higher degree of judgment and complexity:

Allowance for Credit Losses-The allowance for credit losses is established through charges to earnings in the form of a provision for credit losses. Management has established an allowance for credit losses which it believes is adequate for estimated losses in the Company's loan portfolio. Based on an evaluation of the loan portfolio, management presents a monthly review of the allowance for credit losses to the Bank's Board of Directors, indicating any change in the allowance since the last review and any recommendations as to adjustments in the allowance. In making its evaluation, management considers factors such as historical loan loss experience, industry diversification of the Company's commercial loan portfolio, the amount of nonperforming assets and related collateral, the volume, growth and composition of the Company's loan portfolio, current economic conditions that may affect the borrower's ability to pay and the value of collateral, the evaluation of the Company's loan portfolio through its internal loan review process and other relevant factors. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management's judgment, should be charged off. Charge-offs occur when loans are deemed to be uncollectible. The allowance for credit losses includes allowance allocations calculated in accordance with FASB ASC Topic 310, "Receivables," and allowance allocations determined in accordance with FASB ASC Topic 450, "Contingencies."

Goodwill and Intangible Assets-Goodwill and intangible assets that have indefinite useful lives are subject to an impairment test at least annually, or more often, if events or circumstances indicate that it is more likely than not that the fair value of Prosperity Bank, the Company's only reporting unit with assigned goodwill, is below the carrying value of its equity. Goodwill is tested for impairment using a two-step process that begins with an estimation of the fair value of the Company's reporting unit compared with its carrying value. If the carrying amount exceeds the fair value of the reporting unit, a second test is completed comparing the implied fair value of the reporting unit's goodwill to its carrying value to measure the amount of impairment. The Company estimated the fair value of its reporting unit through several valuation techniques that consider, among other things, the historical and current financial position and results of operations of the Company, general economic and market conditions and exit prices for recent market transactions. The Company had no intangible assets with indefinite useful lives at September 30, 2012. Other identifiable intangible assets that are subject to amortization are amortized on an accelerated basis over the years expected to be benefited, which the Company believes is between eight and ten years. These amortizable intangible assets are reviewed for impairment if circumstances indicate their value may not be recoverable based on a comparison of fair value to carrying value. Based on the Company's annual goodwill impairment test as of September 30, 2012, management does not believe any of its goodwill is impaired as of September 30, 2012 because the fair value of the Company's equity exceeded its carrying value. While the Company believes no impairment existed at September 30, 2012, under accounting standards applicable at that date, different conditions or assumptions, or changes in cash flows or profitability, if significantly negative or unfavorable, could have a material adverse effect on the outcome of the Company's impairment evaluation and financial condition or future results of operations.

Stock-Based Compensation-The Company accounts for stock-based employee compensation plans using the fair value-based method of accounting in accordance with FASB ASC Topic 718, Stock Compensation. ASC 718 was effective for companies in 2006; however, the Company had been recognizing compensation expense since January 1, 2003. The Company's results of operations reflect compensation expense for all employee stock-based compensation, including the unvested portion of stock options granted


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prior to 2003. ASC 718 requires that management make assumptions including stock price volatility and employee turnover that are utilized to measure compensation expense. The fair value of stock options granted is estimated at the date of grant using the Black-Scholes option-pricing model. This model requires the input of subjective assumptions.

Other-Than-Temporarily Impaired Securities-The Company's available for sale securities portfolio is reported at fair value. When the fair value of a security is below its amortized cost, and depending on the length of time the condition exists and the extent the fair market value is below amortized cost, additional analysis is performed to determine whether an impairment exists. Available for sale and held to maturity securities are analyzed quarterly for possible other-than-temporary impairment. The analysis considers (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, (iii) whether the market decline was affected by macroeconomic conditions, and (iv) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. Often, the information available to conduct these assessments is limited and rapidly changing, making estimates of fair value subject to judgment. If actual information or conditions are different than estimated, the extent of the impairment of the security may be different than previously estimated, which could have a material effect on the Company's results of operations and financial condition.

RESULTS OF OPERATIONS

Net income available to common shareholders was $46.2 million ($0.82 per common share on a diluted basis) for the quarter ended September 30, 2012 compared with $36.4 million ($0.77 per common share on a diluted basis) for the quarter ended September 30, 2011, an increase in net income of $9.8 million, or 27.0%. The increase is primarily due to the acquisition of ASB. The Company posted returns on average common equity of 9.10% and 9.51%, returns on average assets of 1.32% and 1.52% and efficiency ratios of 46.07% and 42.38% for the quarters ended September 30, 2012 and 2011, respectively. The efficiency ratio is calculated by dividing total noninterest expense (excluding credit loss provisions) by net interest income plus noninterest income (excluding net gains and losses on the sale of assets). Additionally, taxes are not part of this calculation.

For the nine months ended September 30, 2012, net income available to common shareholders was $119.6 million ($2.37 per common share on a diluted basis) compared with $105.3 million ($2.24 per common share on a diluted basis) for the same period in 2011, an increase in net income of $14.3 million or 13.6%. The increase is primarily due to the acquisition of ASB. The Company posted returns on average common equity of 9.08% and 9.37%, returns on average assets of 1.35% and 1.46% and efficiency ratios of 43.69% and 43.41% for the nine months ended September 30, 2012 and 2011, respectively.

Net Interest Income

The Company's net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as a "volume change." It is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as a "rate change."

Net interest income was $106.9 million for the quarter ended September 30, 2012 compared with $82.5 million for the quarter ended September 30, 2011, an increase of $24.4 million, or 29.5%. Included in net interest income for the quarter ended September 30, 2012 is loan discount accretion of $11.2 million related to loans acquired in the 2012 acquisitions. Net interest income increased primarily as a result of an increase in average net interest-earning assets. Interest-earning assets increased to $12.33 billion for the quarter ended September 30, 2012 compared with $8.24 billion for the quarter ended September 30, 2011, an increase of $4.09 billion, or 49.7%. Additionally, the average yield on earning assets decreased 69 basis points from 4.49% for the quarter ended September 30, 2011 compared with 3.80% for the quarter ended September 30, 2012 while the average rate paid on interest-bearing liabilities decreased 22 basis points from 0.69% for the quarter ended September 30, 2011 compared with 0.47% for the quarter ended September 30, 2012. Average interest-bearing liabilities increased $2.99 billion or 48.7% for the same periods. The increases in volumes were due to the acquisition of ASB.

The net interest margin on a tax equivalent basis decreased 50 basis points to 3.52% for the quarter ended September 30, 2012 compared with 4.02% for the quarter ended September 30, 2011. The decrease in the net interest margin primarily resulted from the decrease in the overall yield on interest-earning assets not being matched by a corresponding decrease in the average cost of funds. The average cost of funds was 0.36% for the three months ended September 30, 2012.

Net interest income increased $25.8 million, or 10.5%, to $272.4 million for the nine months ended September 30, 2012 compared with $246.6 million for the same period in 2011. Included in net interest income for the nine months ended September 30, 2012 is loan discount accretion of $11.9 million related to loans acquired in the 2012 acquisitions. The increase in net interest income was mainly attributable to higher average net interest-earning assets for the same periods. The yield on average interest-earning assets decreased at a faster pace than the rates paid on average interest-bearing liabilities. The average yield on earning assets decreased 67 basis points from 4.57% for the nine months ended September 30, 2011 compared with 3.90% for the nine months ended September 30, 2012, while the average rate paid on interest-bearing liabilities decreased 25 basis points from 0.76% for the nine months ended September 30, 2011 compared with 0.51% for the same period in 2012. The net interest margin on a tax equivalent basis for the nine months ended September 30, 2012 decreased 47 basis points to 3.56% compared with 4.03% for the same period in 2011.


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The following tables set forth, for each category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest earned or paid on such amounts, and the average rate earned or paid for the quarters ended September 30, 2012 and 2011 and the nine months ended September 30, 2012 and 2011. The tables also set forth the average rate paid on total interest-bearing liabilities, and the net interest margin on average total interest-earning assets for the same periods. Except as indicated in the footnotes, no tax-equivalent adjustments were made and all average balances are daily average balances. Any nonaccruing loans have been included in the table as loans carrying a zero yield.

                                                                      Three Months Ended September 30,
                                                            2012                                            2011
                                           Average         Interest       Average          Average         Interest       Average
                                         Outstanding        Earned/        Yield/        Outstanding        Earned/        Yield/
                                           Balance           Paid         Rate (4)         Balance           Paid         Rate (4)
                                                                           (Dollars in thousands)
Assets
Interest-earning assets:
Loans                                    $  5,169,101      $  80,587           6.20 %    $  3,694,039      $  54,471           5.85 %
Securities (1)                              7,106,871         37,025           2.08         4,524,213         38,714           3.42
Federal funds sold and other temporary
investments                                    53,111             21           0.16            18,636              4           0.09

Total interest-earning assets              12,329,083        117,633           3.80 %       8,236,888         93,189           4.49 %

Less allowance for credit losses              (53,944 )                                       (52,208 )

Total interest-earning assets, net of
allowance                                  12,275,139                                       8,184,680
Noninterest-earning assets                  1,730,120                                       1,375,394

Total assets                             $ 14,005,259                                    $  9,560,074

Liabilities and shareholders' equity
Interest-bearing liabilities:
Interest-bearing demand deposits         $  2,181,928      $   2,273           0.41 %    $  1,319,800      $   1,667           0.50 %
Savings and money market accounts           3,516,601          2,987           0.34         2,369,745          2,702           0.45
Certificates of deposit                     2,387,279          4,135           0.69         2,134,082          5,348           0.99
Junior subordinated debentures                 85,055            651           3.04            85,055            607           2.83
Securities sold under repurchase
agreements                                    438,410            315           0.29            90,821            127           0.55
Federal funds purchased and other
borrowings                                    512,739            379           0.29           135,336            200           0.59

Total interest-bearing liabilities          9,122,012         10,740           0.47 %       6,134,839         10,651           0.69 %


Noninterest-bearing liabilities:
Noninterest-bearing demand deposits         2,760,405                                       1,828,957
Other liabilities                              92,873                                          66,560

Total liabilities                          11,975,290                                       8,030,356

Shareholders' equity                        2,029,969                                       1,529,718

Total liabilities and shareholders'
equity                                   $ 14,005,259                                    $  9,560,074

Net interest rate spread                                                       3.33 %                                          3.80 %
Net interest income and margin (2)                         $ 106,893           3.45 %                      $  82,538           3.98 %

Net interest income and margin
(tax-equivalent basis) (3)                                 $ 109,031           3.52 %                      $  83,440           4.02 %

(1) Yield is based on amortized cost and does not include any component of unrealized gains or losses.

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